Feeders/Live Cattle Spread: Don’t Get Trampled In This Stampede!

Feeders/Live Cattle Spread

Since December 12th, the IMC blog has been holding a short position in the feeder/live cattle spread. After rolling over, the spread is currently short from the equivalent of approximately +$50,415 (premium feeder contract value) in the August contracts. (Note that we are looking at the difference between the values of the two contracts instead of the market prices. This will make it easier to track the P&L on the trade).

After the huge decline from the October peak to the late February multi-month low, the August feeder/live cattle spread rallied for a month and retraced to the midpoint of the decline. Nearly a month later, it had rolled over again and retraced more than half of the bounce. This should have put the spread on course for a break well below the February bottom.

August Feeder Cattle Live Cattle spread daily

August Feeder Cattle Live Cattle spread daily

Instead, livestock sector firmed from the April correction lows and stampeded higher. This sent the August feeder/live cattle spread running north as well. Yesterday’s close above the March peak was bullish and the spread has gone even higher today, putting the short position in the red for the first time since early January…and you know how things turn out when bulls see red! It currently does not pay to be holding a short position. We don’t want to “mess with the bull and get the horns” so let’s just exit stage right.

The position liquidation is just temporary. Spread traders should be prepared to jump back in once price complies.

October Feeder Cattle Live Cattle spread daily

October Feeder Cattle Live Cattle spread daily

Since we’re soon moving into the summer months, we will start watching the further out October spread instead of the August spread. It’s right on the doorstep of the current 2015 high that was posted on January 5th and it has recovered nearly two-thirds of the October-February decline. It certainly wouldn’t hurt our feelings to see the October feeder/live cattle spread score new 2015 highs and return to the November 18th contract high of +$53,720 (premium feeders) before it rolls over again.

Ridiculously Expensive

Remember that the difference between the value of a 50,000 lbs. of feeder cattle contract and a 40,000 lbs. of live cattle contract has historically been considered expensive when it reached a premium of +$15k! The explosive move higher over the last couple of years is unprecedented as the spread has rocketed into uncharted territory.

Feeder Cattle Live Cattle ratio weekly

Feeder Cattle Live Cattle ratio weekly

Using the ratio to normalize things reinforces this view that feeders are way too pricey in comparison to live cattle. The ratio between the October contracts touched a new high for 2015 this month when it closed at 1.8:1.   On the weekly nearest-futures chart, last year is the first time in history that the ratio has ever reached 1.8:1. Historically, it is considered ‘expensive’ once it reaches 1.6:1. The October ratio has never even been as low as 1.6:1 yet! Therefore, we know that the spread and the ratio remain at unsustainable levels. History shows that the ratio has always gone back down to 1.3:1 or lower after reaching 1.6:1 or higher. This is exactly why spread traders had better keep a close eye on the October feeder/live cattle spread. A new short sale signal is a high-probability trade that could offer some homerun returns.

Trade Strategy:

Buy back the one short 50,000 lb. August feeder cattle contract and simultaneously sell the one long 40,000 lb. August live cattle contract at +$51,000 (premium feeders) or better. Cancel any outstanding ‘add-on’ orders.

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Live Cattle/Lean Hog Spread: Liquidate the Short Position

Live Cattle/Lean Hog Spread

The IMC blog entered a hypothetical short position in the December live cattle/lean hog spread at 83.50 (premium cattle) on April 15th. Initially, we were going to risk a close above 90.00 (premium cattle) so that it would take a breakout to new contract highs to knock us out.

After sitting in a trading range for several weeks, the December live cattle/lean hog spread made a breakout to the upside. Today will likely be the third-consecutive day that it closes back above the 84-cent mark as well. This price action argues for a test of the contract highs. Therefore, it may be prudent to go ahead and take a partial loss right here in the hopes that we can reposition at a higher level.

December Live Cattle Lean Hog spread 3-minute

December Live Cattle Lean Hog spread 3-minute

Despite the recent bounce, it is important to keep the big picture in mind. Both the spread and the ratio between live cattle and lean hogs are at high levels that are rare by historical standards. In the past, both the spread and the ratio have always turned back down and gone to levels that are less than half of where they are now. Therefore, we are still very excited about the short side of this trade. The current liquidation is just a little bit of fine-tuning.

Trade Strategy:

Buy back the one short 40,000 lb. December live cattle contract and simultaneously sell the one 40,000 lb. December lean hog contract at a spread of 85.75 or better.

However, let’s keep the ‘add-on’ order working to sell one 40,000 lb. December live cattle contract and simultaneously buy one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). If filled, risk a two-day close .50 points above the highest price that follows the April low. That way, we have a setup that gets us back in the spread in the event that our current bailout is ill-timed.

T-bond/T-note Spread: The Recent Position Was Stopped Out. Let’s Liquidate the Rest.

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds). The initial position was entered in the March spread on February 6th.

An ‘add-on’ was entered on February 20th. This second position in the June T-bond/T-note spread is currently short from the equivalent of approximately 32-30 (premium T-bonds).

Another ‘add-on’ was entered on May 20th when the June T-bond/T-note spread closed at 25-14.5. This third position was exited at today’s close of 28-21.5 for a loss of approximately -$3,218.75 per spread.

June T-bond T-note spread daily

June T-bond T-note spread daily

The June T-bond/T-note spread plunged eleven full points from the late January record high in just over five weeks. After a nearly one-month rally into the April Fool’s Day secondary top, the spread once again plunged nearly eleven full points over the following seven weeks. Based on this symmetrical pattern, it may be due for another bear market rally.

If the spread makes another bear market rally that is similar in size and duration to the March/April bear market rally, it could run until mid-June and peak somewhere near 32-16. Coincidentally, this is just past the Fibonacci .618 retracement of the decline from the April peak. Therefore, we advocate booking the current profits and looking for a new setup to reenter the short side of the spread if it trades north of 32-00 again.

Trade Strategy:

On the short June T-bond/T-note spread entered at the equivalent of approximately 35-08 (premium T-bonds) and the ‘add-on’ spread entered at the equivalent of approximately 32-30, liquidate the spreads at 28-22 or better in the after-hours market.

Gold/Silver Spread: Take a Quick Profit Now So We Can Reenter At a Better Price Later

Gold/Silver Spread

Hypothetically, the IMC blog has been holding a short position in the June-July gold/silver (x7,000/oz.) spread from the equivalent of approximately +$4,123 (premium gold) since January 14th.

This spread has been in a big, fat trading range since the end of last year as it has traded both above and below the +$6k mark every single month since November. It is historically high (ergo, the short position), but the lack of a south-bound breakout has kept us hostage since the start of the year.

June Gold July Silver (7,000 oz.) spread daily

June Gold July Silver (7,000 oz.) spread daily

In mid-May the June-July gold/silver (x7,000/oz.) spread cracked support at the March low and closed below ‘even money’ for the first time since the first week of October. Alas, there was no follow-through to the downside. The spread reversed higher, triggering a Wash & Rinse buy signal (false breakout). Therefore, we think it would be prudent to go ahead and exit the current position with a bit of a profit right here so we can look to reenter when it gets back above the +$6k mark. This will give us a better average entry price.

Trade Strategy:

Buy back the one short 100 oz. June gold contract and simultaneously sell the one 5,000 oz. July silver contract and two 1,000/oz. July ‘mini’ silver futures contracts at +$2,000 (premium gold) or better here in the after-hours market.

 

Feeder/Corn Spread: Another New Short Sale Setup

Feeder Cattle/Corn Spread

Over the last couple of months, the livestock markets have been on a rebound. At the same time, the feed grain markets have continued to slide. This has caused a recovery in the spread between feeder cattle and corn.

August Feeders September Corn (x6) spread daily

August Feeders September Corn (x6) spread daily

The August-September feeder/corn (x6) spread dropped nearly $31k in value as it declined from the October 3rd contract high into the December/February double bottom. Since then it has retraced more than two-thirds of the decline, closing at a seven-month high of -$300 (premium corn) today.

Historic Extremes

At today’s closing prices, the ratio between the value of one August feeder futures contract and one 5,000 bushel September corn futures contract neared 6:1. This is a rare event. Over the last four decades, there have only been a few times when the feeder/corn ratio made it to 4.8:1 (nearly five-to-one) or higher. Each time, it eventually reversed and plunged to 3:1 or lower. Therefore, history suggests that the current relationship is unsustainable. The feeder/corn (x6) spread is very likely to make a major reversal, followed by a significant decline.

The Current Setup

On Monday the August-September feeder/corn (x6) spread pulled back to a nearly three-week low and tagged the rising 20-day Moving Average. It then recovered and ended the week at a new multi-month high. If the recovery fails and the spread closes below the 20-day MA for the first time in a month and cracks the May 18th reaction low, it could indicate that the recovery has ended. If so, traders would have a good reason to start attacking the spread from the short side again.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 50,000 lb. August feeder cattle contract and simultaneously buying six 5,000 bushel September corn contracts if the spread closes below -$4,250 (premium corn). Initially, the spread will be liquidated on a two-consecutive day close $500 above the multi-month rally high that precedes the entry (currently at -$300).

Hog/Corn Spread: Another Short Sale Opportunity?

Lean Hog/Corn Spread

Remember the ol’ hog/corn spread? It’s been making a comeback. The August-September hog/corn spread has risen over 50% from the multi-month low that it posted just two months ago. A new trading opportunity may be shaping up.

Recall that this spread works because of the relationship between the end product (hogs) and the feed costs (corn). The feed counts for two-thirds to three-quarters of the cost of production.

When the price of end product gets too far ahead of the production costs, the rising profit margin inevitably brings in more supply and smashes the market. Conversely, when production costs become too expensive, producers lose profit margin, supplies shrink, and the market inevitably rebounds.

Historic Price Parameters

The ratio between 100 lbs. of hogs and one bushel of corn is considered normal when it is somewhere between 22:1 and 25:1. The current prices of August lean hogs and September corn set the ratio just under 23:1. This is nothing to write home about. Historically, the high-probability short sales show up after the ratio surpasses 32:1.

Hog Corn spread weekly

Hog Corn spread weekly

However, the spread between the values of one 40,000 lb. August lean hog futures contract and one 5,000 bushel September corn futures contract hit a multi-month high of +$15,640 (premium hogs) just last week. This is something to pay attention to. Since the hog/corn spread first reached the +$15k level thirty-three years ago, there have only been seven times when the spread reached +$15k or higher, basis the weekly nearest-futures. Each time, the spread eventually rolled over and dropped $17,000 or more from the highs. Therefore, the August-September hog/corn spread is now a short sale candidate.

The Current Setup

The August-September hog/corn spread established a double top at the October and November peaks and then dropped precipitously into the March 23rd low. On May 5th the spread closed above the Fibonacci .618 retracement of the entire decline and temporarily peaked a week later. This is an ideal place for a secondary lower high to be established. We now need to see some evidence that the two-month rally is over before taking a shot at the short side.

The August-September hog/corn spread made a four-day pullback of $1,182.50 from the April 13th high. It bottomed just above the rising 20-day Moving Average and resumed its uptrend. The spread then made a made a five-day pullback of $1,102.50 from the May 12th high. It appears to have bottomed just above the rising 20-day Moving Average again. Currently, the spread is in the middle of a two-day bounce as it has already recovered more than half of the recent pullback.

August Lean Hog September Corn spread daily

August Lean Hog September Corn spread daily

If the bounce fails, it could be high time to short the August-September hog/corn spread since it would be back under the major Fibonacci .618 resistance line, beneath the recent May 18th pullback low, and below the 20-day MA for the first time since late March.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 40,000 lb. August lean hog contract and simultaneously buying one 5,000 bushel September corn contract if the spread closes below +$14,500. Initially, the spread will be liquidated on a two-consecutive day close $500 above the multi-month rally high that precedes the entry (currently at $15,640).

T-bond/T-note Spread: An ‘Add-On’ Trade Was Triggered

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds).

The blog initiated an ‘add-on’ position on February 20th at the equivalent of approximately 32-30 (premium T-bonds).

The blog initiated a second ‘add-on’ position yesterday on May 20th at approximately 25-14.5 (premium T-bonds) when the June T-bond/T-note spread closed below the May 13th correction low. This new ‘add-on’ position will be liquidated on a two-consecutive day close above 27-24, which is just above the May 15th reaction high.

June T-bond T-note spread daily

June T-bond T-note spread daily

During this nearly four-month decline, the June T-bond/T-note spread has dropped about 35 full points from the record high. As the trend progressed favorably, ‘add-on’ setups gave traders opportunity to increase the position size. Adding to winning positions is the way to take full advantage of a trending market. With no price support seen until the spread drops another eleven full points from here, hopefully even more setups will come along.

Live Cattle/Lean Hog Spread: An ‘Add-On’ Setup For a Short Sale

Live Cattle/Lean Hog Spread

The blog is currently holding a hypothetical short position in the December live cattle/lean hog spread entered at approximately 83.50 (premium cattle) on April 7th.

The live cattle/lean hog spread exploded to new record highs in Q4 of 2014. Even though it has backed off from the peak, it is still extremely overpriced. The December spread is currently around 82.00 (premium cattle). Historically, this spread was usually considered to be very expensive whenever it reached 35.00! Previous runs to this level were followed by a reversal that sent the live cattle/lean hog spread back below 20.00 (premium cattle). Therefore, it still has quite a low of downside potential.

Live Cattle Lean Hog spread monthly

Live Cattle Lean Hog spread monthly

The December live cattle/lean hog spread established a multi-month low of 74.35 on December 16th. After an explosive two-week rally, the spread backed off again and bottomed in February just above the December low. From there it launched a one-month run into new contract highs.

The Fibonacci .618 retracement of the entire move from the December 16th low to the March 23rd contract high offered support at 80.17. The December live cattle/lean hog spread neared this level in mid-April when it bottomed at 80.47 and bounced.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

Currently, the spread finds near-term support between the April correction low and the Fibonacci .618 retracement. A break below this level should confirm that the downtrend from the March peak is still in play. This would give traders a reason to initiate another short position. Risking to just beyond the current bounce off the April low provides a low-risk setup on the trade as well. And with price expected to eventually reach a significantly lower level, the reward-to-risk ratio is very attractive on this trade. It could be as high as 12:1! Therefore, aggressive spread traders could use this setup as an opportunity to add to short positions.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical ‘add-on’ trade by selling one 40,000 lb. December live cattle contract and simultaneously buying one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). If filled, risk a two-day close .50 points above the May high that precedes the entry.

T-bond/T-note Spread: Another ‘Add-On’ Setup Has Materialized

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds). The initial position was entered in the March spread on February 6th.

An ‘add-on’ was entered on February 20th. This second position in the June T-bond/T-note spread is currently short from the equivalent of approximately 32-30 (premium T-bonds).

On Thursday the spread closed at a new multi-month low of 25-18.5. At that point, the six-week decline of nearly eleven full points from the April Fool’s Day high was similar in size and duration to the five-week decline of the eleven full points from the January 28th all-time high to the early March correction low. Therefore, the two-day bounce that followed was not a surprise. It could have even been the start of a new bear market rally.

June T-bond T-note spread daily

June T-bond T-note spread daily

Since peaking at a secondary (lower) high on April Fool’s Day, bounces in the June T-bond/T-note spread have been one to three-day affairs. Therefore, a break to new lows after the recent two-day bounce could indicate that the bearish pattern is still intact and that the symmetry of price and time will be broken. This could keep the spread on course for a return to the mid-October low of 14-07.5.

The short-term bounces offer a low-risk entry for short sellers to enter on a break to new corrective lows and risk just above the preceding bounce high. The low risk on the trade, combined with a sizable downside target, creates a lucrative reward-to-risk scenario. Traders who are already short could use this setup as an opportunity to increase the position size again.

Trade Strategy:

The blog will make a hypothetical ‘add-on’ trade by selling one June T-bond contract and simultaneously buying one June T-note contract on a close below the May 13th low of 25-18.5. Initially, this ‘add-on’ position will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the highest closing price between the May 13th low and the entry day.

 

Cocoa/Sugar Spread: An Exit Signal and Some Reentry Parameters

Cocoa/Sugar Spread Exit

The blog entered a hypothetical short position in the cocoa/sugar spread back on October 3rd. We rolled over a couple of times and were last in the July contracts, so the spread position was short from the equivalent of +$12,256 (premium cocoa).

On Wednesday, May 13th the July cocoa/sugar spread closed above +$15k for the second day in a row. This triggered the exit criteria. Therefore, the position was liquidated at approximately +$16,044.80. The trade resulted in a hypothetical loss of $3,788.80 (not including commissions).

At today’s new closing high of +$16,499.20 the spread is not too far from nearest-futures 2010 top at +$16,589.60 or the 2014 top at +$17,510.40. It is still a qualified candidate for a trade on the short side.

Cocoa Sugar ratio daily

Cocoa Sugar ratio daily

Furthermore, the ratio between the value of one cocoa contract and one sugar contract hit 2.15:1 today. This is right on the doorstep of last year’s peak at 2.16:1, which was the highest ratio since the end of 2008. This confirms our opinion that the spread is pricey.

New Parameters

Since the cocoa contract is now worth more than double the value of the sugar contract, a spread trader can create a more dollar neutral spread by trading one cocoa contract against a pair of sugar contracts.

September Cocoa October Sugar (x2) spread daily

September Cocoa October Sugar (x2) spread daily

When plotting the spread between one September cocoa contract and two October sugar contracts, we can see that it closed at a new contract high of +$1,182 (premium cocoa) today. We can also see that the trend is fairly strong as the September cocoa/October sugar (x2) spread has only closed below the rising 30-day Moving Average on one occasion in the last three and a half months. Therefore, a two-day close below the 30-day MA for the first time since the start of February and a break below the current May low (where the spread last bounced off the 30-day MA) might be a good reason to take another stab at the short side.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 10-ton September cocoa contract and simultaneously buying two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 30-day MA (currently around -$1,368.43) or a one-day close below the May 8th reaction low at -$1,557.20 (premium the sum of the two sugar contracts), whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.